The Markets October 18, 2018

How Rising Interest Rates Affect Stable Value Funds

While money market funds may look more appealing in the short run, this is not expected to last.
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Since stable value funds invest in intermediate-term bonds and money market funds favor short-term bonds, the recent rise in short-term interest rates has been creating some challenges for stable value funds.

Experts say, however, that this condition is cyclical, and stable value funds still hold great appeal for retirement plan sponsors and participants.

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“The interest rate environment over the past 12 months has been very challenging for stable value funds,” says Jonathan Kreider, vice president of investment products at Great-West Financial in Greenwood Village, Colorado. “One headwind has been the general flattening of the yield curve, which is cyclical.”

Another headwind, according to Krieder, is “more structural.” He says the long-running bull market in equities has left investors in general less focused on defensive funds and capital preservation.

“All bull markets come to an end,” he warns.

John Faustino, chief product and strategy officer at Fi360 in Chicago, agrees that while the increase in short-term interest rates can make stable value funds “a little bit less attractive” than money market funds, in his experience this is usually a short-lived phenomenon.

“It is true that rising short-term interest rates could create yields in money market funds that exceed those of stable value funds,” Faustino says. “Over the past 50 to 60 years, there have been 10 times when the yield curve inverted, whereby three-month Treasury yields, more similar to money market durations, have been higher than five-year Treasuries, more similar to stable value duration.”

What is important to note, he says, is that when those inversions did occur, they only persisted for five to six months.

“Since many stable value funds have provisions that require a plan sponsor to give 12 months’ notice before moving to a competitive product, it likely won’t make any sense for a plan sponsor to move,” Faustino says.

Kreider says it is also important to note that, if increases in interest rates occurs slowly over time, stable value funds’ crediting rates will be responsive to this.

“There will be fewer losses in the underlying bonds, so the crediting rate is unlikely to decline,” he says. “If the interest rate move is rapid, however, crediting rates might actually drop in the face of higher interest rates.”

Additionally, the experts agree on the importance of being aware of the fact that, while stable value fund returns can fall behind those of other products invested in short-term bonds, generally speaking the lag is quite temporary compared with the long-term investment horizons of retirement savers.

Gary Ward, head of stable value at Prudential Retirement in Newark, New Jersey, says that the recent market volatility should be a reminder to plan sponsors and participants of the critical role that stable value funds offer them. Since stable value funds offer steady returns with guaranteed principle, participants may want to include them in their portfolio, he says.

“In times of market volatility, it’s an opportune time for individuals to review their asset allocation, to ensure they have a diverse portfolio that aligns with their investment needs, and rebalance as necessary,” Ward says.

Additionally, with interest rates now rising, it is important to be aware that stable value products are built to be responsive to rate increases without volatility in the returns, Ward says. “Stable value products are built for different market cycles and interest rate conditions, offer long-term benefits and are ideal for long-term savings vehicles like defined contribution plans.”

When considering a stable value fund, sponsors and advisers should conduct a thorough due diligence process, Kreider says. This includes looking at “the credit rating of the issuer, the composition of the investment portfolio, the capital and reserves available to support guarantees, the historical crediting rates of the portfolio, termination provisions and any potential recordkeeping reductions associated with the use of the product.”

Client Service October 8, 2018

Open MEPs Could Create Many Opportunities for Advisers

Should Congress or federal regulators eliminate the common nexus and bad apple rules that have held back open multiple employer plans, experts anticipate many more small businesses will jump in.
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Some experts in the retirement planning industry think that if the executive order issued earlier this year to the Department of Labor (DOL) and the Treasury on expanding open multiple employer plans (MEPs) finds success, this could result in many more small businesses offering MEPs—which will in turn open up new opportunities for advisers.

“Even if there is only a marginal uptick, there will be more opportunities to serve multiple employer plans,” says Adam Pozek, chief financial officer of DWC—The 401(k) Experts, in Boston.

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However, Karen Scheffler, senior Employee Retirement Income Security Act (ERISA) counsel at Alliance Bernstein, in New York, says the future of open MEPs may ultimately be determined by what happens legislatively.

“It depends on what the final legislation says with regard to MEPs,” Scheffler says. “If the common nexus and bad apple rules are eliminated, it reduces some of the disincentives to join these plans. However, there are other factors that will go into whether a small business owner will find open MEPs appealing. We don’t know what a recordkeeper will charge for this type of program. Also, the fiduciary liability relief has not been determined, and the complexity of these plans may make it difficult for an employer to know what they are selecting.”

Should open MEPs become more common, however, this will drive many opportunities for retirement plan advisers, Scheffler says. “Advisers will still have a significant role with regard to advising plan sponsors,” she says. “While MEPs simplify the day-to-day process, the employer still has to understand the features and requirements of the plan, and advisers can play a key role in that.”

Stuart Robertson, president of Capital One Advisors 401k Services, in Seattle, agrees.

“While MEPs would standardize the investment lineup, thereby reducing advisers role in that respect, plan sponsors always need help with plan design, educating participants and knowing their fiduciary duties, so there would still be plenty of work for advisers to do,” he says.

Furthermore, there will still be plenty of small businesses that don’t decide to join a MEP and that will need the help of a retirement plan adviser, Pozek says.

Some specialist advisers could even create their own open MEP, says Tom Conlon, head of client relations at Betterment for Business in New York. “It would be a perfect opportunity for an adviser to create a fund lineup for multiple employers and leverage their research and fiduciary oversight,” he says.

Should they do so, it is likely that the retirement plan adviser will partner with a recordkeeper, which would serve as the administrator and maintain documents, Scheffler says. The adviser’s role would be to attract companies to the MEP and manage the investments, she says.

The executive order also calls for the electronic delivery of disclosures to participants. “While some participant populations have regular access to computers at work and home, others don’t,” so it may not be feasible, Scheffler says. Nonetheless, she adds, “electronic delivery is the wave of the future.”

Finally, the executive order asks the DOL and Treasury to explore whether the required minimum distributions should be raised beyond age 70.5, due to longer life spans. This could encourage participants to remain invested in their workplace retirement plans past retirement and, possibly, motivate sponsors to offer retirement income options.

“In my view, it would be a good idea for plan sponsors to think about offering retirement income options regardless of the required minimum distribution rule,” says Jennifer Delong, head of defined contribution at Alliance Bernstein. Conlon agrees: “We think it is a really good thing when plan sponsors offer in-plan income options.”

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